Many observers seem confused. They express disappointment that the so-called "Trump trade", a rally in the dollar has not materialized. Yet, in some ways, isn't that what happened from late last September, ironically around the Federal Reserve's 50 bp rate cut, around the time investors began taking US election polls more seriously? In Q4 24, the Federal Reserve's real broad trade weighted dollar index rose by 4.9%, the best quarterly performance since Q4 2016. From late last September through a week before President Trump's second inauguration, the Dollar Index rose by about 10%. Since January 10-13, the "Trump trade" in the foreign exchange has been unwinding. With momentum indicators stretched and the US tariff threat about to enter a new phase next month, a key question is how much more of the greenback's gains will be unwound? We have suggested that it is almost over and that still seems to be a fair assessment.
The data highlights in the week ahead are unlikely to alter expectations for central bank policy and may pale in significance compared to the US tariffs that may be implemented as soon as next month. It is now well appreciated that the stronger than expected rise in the US CPI and PPI will not be echoed in the measure of prices that the Fed explicitly targets, headline PCE deflator. Tokyo's February CPI, which is a good gauge of changes in the national figure that is reported with a several week lag, is expected to moderate as energy subsidies were renewed. Excluding fresh food and energy, Tokyo's CPI may have edged up to 2.0% from 1.9%. Canada reports December and Q4 24 GDP. The economy contracted by 0.2% in November (+0.3% in October). However, US tariffs as early as March 4 will likely be more important for the interest rate and policy outlook. China reports its February PMI on March 1. A small increase is expected.
US
Drivers: Between the assorted tariff threats and peace talks to end Russia's war in Ukraine, without involving Kyiv or Brussels, and assorted acts from petty, like renaming a body of water, to the reckless, like unilateral disarmament by ending USAID and other soft-power projections, the US has become the main disruptive force in the world. Although many have suggested “tariff fatigue," the US tariff threat enters a new phase in March. The 25% tariffs on Canada and Mexico, ostensibly over immigration and fentanyl will be revisited in early March. Steel and aluminum tariffs are threatened for March 12. The reciprocal tariffs and auto tariffs may be a few weeks later. Investors, businesses, and economists continue to wrestle with potential supply shock on one hand, with inflationary implications, and the consequential weaker demand on the other hand. Moreover, the focus on the tariff threats is sucking the oxygen from other issues. In particular, the move on immigration and firing of thousands of federal government workers will likely have profound implications for the labor market, consumption, and growth.
Data: The higher-than-expected CPI and PPI readings were noisy. The real implication is that the headline and core PCE deflators likely slowed. The headline January PCE deflators may come in at 2.5%, down from 2.6%, while the core looks like 2.6% compared with 2.8% in December. Meanwhile, personal income and consumption looks to have slowed sequentially in January to a still respectable 0.3% month-over-month pace. Alongside the January durable goods orders will help give a better sense of the pace of growth in Q1 25. January housing starts will feed into residential investment. Halfway through the quarter, and the Atlanta Fed's model has the economy tracking a 2.3% annualized pace, roughly the same as Q4 24. There are a bevy of regional Fed surveys, and the Conference Board's consumer consider survey (expect some deterioration), but they typically have negligible impact.
Prices: The Dollar Index met the (38.2%) retracement objective of the rally from the low last September (~100.15) near 106.35 last week. The next retracement (50%) is near 105.15. The five- and 20-day moving averages are falling, and while stretched, the momentum indicators have not turned up. Still, with a new phase in the US tariff threat beginning next month, we continue to look for a reversal pattern or some other price action to indicate that the downtrend since January 13, when the Dollar Index peaked (~100.15) is over. A move above 107.40 would improve the technical tone.
EMU
Drivers: The US tariff threats, its peace talks with Russia, and the appearance of officials (e.g., Vance and Musk) interfering the German election is causing a crisis in the Atlantic alliance that has not been seen since at least the 1956 Suez Crisis. One of the implications is that between the costs rebuilding Ukraine and boosting defense spending, the supply of long-term European bonds will most likely have to increase. Russia's invasion of Ukraine was disruptive for the EU and the possibility of the end of the war appeared to help lift the euro initially. The swaps market has settled down and looks for two more ECB rate cuts in H1 25 and one in the second half. The results of the Germany election will be known before the markets open on Sunday. There is little doubt that the CDU will come out ahead but is unlikely to secure an outright majority. An alliance with the SPD and Greens looks likely. The AfD may come in second place but in the parliamentary system second place does not ensure it will be asked to join the government. And in this case, it will not.
Data: The economic calendar is light on market moving high-frequency data. Credit figures released with the money January money supply may show continued improvement on the margin. The EC confidence surveys typically do not elicit much reaction. The ECB's one- and three-year inflation surveys are also of passing interest, which for the record stood at 2.8% and 2.4%, respectively at the end of last year.
Prices: The euro tested two-month highs last week and they held. The euro reached nearly $1.0525 on January 27 and $1.0515 on February 14 (following the unexpectedly poor US retail sales and decline in manufacturing output). It peaked near $1.0505 last week. Support was tested around $1.04 in the middle of last week. Only a break of that range is important. The US tariff threat enters a new phase next month and there is little doubt in the market's mind that the ECB will cut rates again on March 6.
China
Drivers: Contrary to speculation, Beijing has not attempted to offset the recent new 10% US tariff on Chinese imports with currency depreciation. The dollar peaked against the yuan a week and a half before Trump's inauguration. China wants neither a strong nor weak yuan, but one that is broadly stable against the US dollar. Many observers see China as a primary beneficiary of recent US actions, including the freeze of foreign aid, the closing of USAID, and the broad tariff threat. For its part, China has announced it was eliminating tariffs on the imports from the world's poorest countries. At the same time, Xi appears to be following Napoleon's advice: "Never interrupt your enemy when he is making a mistake." This is not a partisan assessment but from Beijing's perspective, the US is wreaking havoc and discord through its alliance and unilaterally disarming some of the elements of its power projection.
Data: China's domestic economy still needs support, but the PBOC does not appear to be poised to cut rates or reserve requirements now. The one-year Medium-Term Lending Facility rate has been downgraded as a key benchmark, but the lending volume may increase. On March 1, China reports the February PMI. Recall that in January, the manufacturing PMI fell to 49.1 (from 50.1), a five-month low and matching the 2024 low seen in February and again in August. The non-manufacturing PMI fell to 50.2 (from 52.2). It has not been below 50 since December 2022. The composite stood at 50.1 in January, matching the 2024 low set in August.
Prices: The dollar made a marginal two-month low against near CNH7.23 last week and rebounded ahead of the weekend to settle at CNH7.2550. Still, the dollar slipped for the third consecutive week, matching the longest decline in four years. Contrary to expectations, the yuan has strengthened by about 1% since the US announced its new 10% tariff on imports from China. The US 10-year premium over China is less than 275 bp, the least in two months, and the index of mainland companies that trade in Hong Kong are up nearly 19% this year. Meanwhile, the PBOC continues to set the dollar's reference rate in a narrow range ensuring the yuan remains relatively stable against it.
Japan
Drivers: The exchange rate seems to be buffeted by two main forces: the US interest rates and the BOJ monetary policy. Its appearance as a safe haven seems to be more a function of the use of the yen as a funding currency (carry trades) and through the US interest rate channel. Last week, developments in Japan seemed to be the more crucial factor. Provided the economy and prices evolve as the BOJ expects, Governor Ueda is committed to normalizing Japanese monetary policy, and indeed that is what is happening. The dollar peaked against the yen last month the same day it peaked against the Chinese yuan (January 10) but the rolling 60-day correlation between the two has weakened sharply since the carry trade unwind last July, from around 0.80 to now near 0.20. It is not clear the Trump administration will grant Japan exemptions from its metals and reciprocal tariff threats. Japan records an overall trade deficit but a bilateral surplus with the US.
Data: Japan reports January industrial production and retail sales both are likely to improve sequentially (from 0.3% and -0.7%, respectively), but the most important data point is Tokyo's February CPI. It signals the general development of the national CPI figure, which will not be reported for several weeks. The headline rate stood at 3.4% in January, the highest since April 2023, and was flattered by the end of household energy subsidies before the new subsidies kicked in. Fresh food prices include rice in Japan and rice prices have been steadily increasing, and this poses upside risks for Tokyo CPI. Excluding fresh food and energy, Tokyo's inflation has been hovering between 1.8%-1.9% for four months through January.
Prices: The dollar met the (50%) retracement objective of the rally from the mid-September 2024 low (~JPY39.60) found near JPY149.20 and slipped below JPY149 ahead of the weekend. That was greenback's low since early last December when it bottomed around JPY148.65. Although the exchange rate is often more correlated with changes in the US 10-year Treasury yield, the first half of last week seemed more about JGB yields and the spread, which narrowed to almost 300 bp, the least in three months. In the middle of last September, when the dollar was forging an important low, the spread briefly narrowed inside 280 bp. The US 10-year yield slumped 17 bp in the past three sessions to 4.40%. The dollar has fallen by about 6.25% against the the yen since peaking on January 10. The momentum indicators are stretched but have not turned higher. A move above JPY151 might help stabilize the technical tone but the dollar must regain the JPY152.40-60 area to lift the outlook.
UK
Drivers: Sterling tumbled nearly 10% from late September through mid-January. The fall and subsequent recovery tracked the US dollar movements broadly. Sterling's rolling 60-day inverse correlation with changes in the Dollar Index is near a three-year high, a little below 0.70. The rolling 60-day correlation of changes in sterling and euro reached a six-month high near 0.85 last month and is now slightly below there. The UK two-year yield is back at the same level as the US two-year yield. It was had a six-basis point premium a week ago. The UK's 10-year premium rose to 11 bp, the upper end of where it has traded in nearly four months.
Data: The UK data is of tertiary interest. The February CBI reported sales and Nationwide house price index do not capture much attention from market participants. The swaps market sees little chance of another BOE rate cut next month, but strongly (~82%) favors one in May. Prime Minister Starmer's visit to the Washington may swamp the data. However, the British-French proposal for 30k-European "reassurance force" will look too much like a NATO operation for Moscow to find it acceptable. and the British Prime Minister may find it even more difficult to alter America's new strategic path, which includes tariffs. Fortunately, US and UK bilateral trade is sufficiently confusing that both sides can show a small bilateral surplus.
Prices: Sterling rose to a new two month high before the weekend near $1.2680. It was the third consecutive weekly advance, which matches its longest advance since last April. It met the (38.2%) retracement of the nearly 10% Q4 24 slide that carried into mid-January, which was found around $1.2610. The next retracement (50%) is near $1.2765 and the 200-day day moving average is slightly below $1.2790. Sterling has been bumping against its upper Bollinger Band (~$1.2680 before the weekend), and while the momentum indicators are over-extended, they have not turned down. Still, the close was poor, near session lows set late in the session. A break of $1.2550 weakens the technical tone.
Canada
Drivers: The US dollar was driven to nearly CAD1.48 when it seemed like a 25% tariff was about to be slapped on all of Canada's exports to the US but energy, which would face a 10% levy. Such a shock to the Canadian economy was expected to spur the Bank of Canada to cut rates more aggressively. When the postponement was announced, Canada's two-year discount to the US narrowed and the Canadian dollar strengthened. The markets wobbled on the US threat of 25% duties on aluminum and steel, for which Canada is the largest foreign supplied, but the implementation date--March 12--was seen to allow time for negotiations and this saw a rather muted market reaction. Ideas that the US CPI and PPI overstated the price pressures measured by the PCE deflator, which the Fed targets, and the disappointing January retail sales and manufacturing output spurred a broader US dollar pullback, and the Canadian dollar rose to new highs since mid-December.
Data: Canada reports December and Q4 24 GDP figures. The data is too old, given the recent developments to have much impact. That said, growth likely accelerated to around 1.5%-1.6% at an annualized rate from 1.0% in Q3 24. However, the composition looks different. Consumption and government spending likely slowed, but fixed investment and net exports appear to have improved. Since Q4 22, Canada has recorded a small (less than 1% of GDP) current account deficit, and even that has been trending lower since Q3 23. However, the Q4 24 shortfall may have more than doubled form 0.33% of GDP in Q3 24. The swaps, market is discounting almost of 50% chance of a cut at the next Bank of Canada meeting on March 12.
Prices: The greenback appear to have forged a near-term shelf above CAD1.4150. The upside has been and settled firmly even if a little below last week's week's high (~CAD1.4245. The momentum indicators look poised to turn higher. Above the CAD1.4250-60 area, the next hurdle is around CAD1.4300. Overcoming that cap could spur a move back into the CAD1.44-CAD1.45 area.
Australia
Drivers: The rolling 60-day inverse correlation of changes in the Australian dollar and Dollar Index has eased from around 0.70 around the US election in early November to slightly less than 0.55 at the end of last week. It has firmed slightly over the past couple of weeks. On the other hand, the 60-day correlation of changes in the Australian dollar and Canadian dollar is slightly above 0.70. Australia's two-year yield discount to the US exceeded 50 bp earlier this month, the most since last July. It is now less than 35 bp. It was briefly at a premium in late September 2024, around when the Aussie peaked near $0.6940. Prime Minister Albanese hoped that Australia would be granted an exemption from US steel and aluminum tariffs, but Trump trade advisor Navarro argued forcefully against it.
Data: Australia's January monthly CPI print is due. The central bank still puts more stock in the quarterly reading. Australia's monthly CPI bottomed last September and October at 2.1%. It rose in November and December to finish the year at 2.5% In January 2024, the CPI stood at 3.4%. While the RBA began its easing cycle last week, it sounded cautious. The market does not have the next cut fully discounted until July.
Prices: The push to almost $0.6410 before the weekend, the Australian dollar's high since mid-December nearly met the (38.2%) retracement of the slide from (~$0.6940) last September to about ($0.6090) in early February. The (50%) retracement is another cent higher. The Aussie flirts with the upper Bollinger Band (~$0.6400), and while the momentum indicators are stretched, they have not turned down. It settled near session lows recorded in late North American turnover near $0.6350. Support is seen near $.6330.
Mexico
Drivers: The US tariff threats roiled the peso initially, but subsequent threats, like on steel and aluminum had noticeably less impact. Still, postponement of the 25% tariff due to undocumented immigration and fentanyl may still come into force in early March. Steel and aluminum tariffs could be implemented on March 12, and the auto tariffs are threatened for early April. In addition, the US has threatened to designate Mexico's drug cartels as "terrorist organizations," which would empower the US military. Mexican President Sheinbaum has threatened to retaliate by expanding a lawsuit against US gun manufacturers.
Data: Mexico's economic calendar has two three highlights in the last week of the month. First is the inflation report for the first half of February. Mexico's inflation is back within the target range, the economy has slowed, and US tariff threats are potentially a powerful headwind. Second, Mexico reports January trade figures. Mexico recorded a trade surplus last year of about $170 bln with the US. Yet, an estimated 30% to 40% of Mexico's exports to the US originate from affiliates of US companies. At the lower end of estimates, Mexico trade surplus all but disappears. That underscores our sense that US corporate foreign direct investment strategy is a key target of the new US administration's tariff policy. Third, Mexico reports January unemployment figures. Unemployment has risen in Januarys for the last 19 years without exception.
Prices: Like the Canadian dollar, the peso has strengthened for three consecutive weeks. They both recovered in full from the tariff-threat sell-off earlier this month. Both seem vulnerable to the new tariff phase next month. Last week's low was near MXN20.20 and the January low was closer to MXN20.1350. The momentum indicators are stretched but also have not turned higher. A move above MXN20.48-MXN20.50 would lift the tone.
Reviewed by Marc Chandler
on
February 22, 2025
Rating:
